Slim Index Pickings In 401(k) Plans

Ron Lieber argues that 401(k) plans should offer index funds. “This shouldn’t be a controversial statement,” he writes in a recent New York Times article. “Yet it passes for one in Washington, where regulators and legislators are still mired in a never-ending debate over whether stockbrokers, certain insurance salespeople and others ought to meet that standard, known in legal circles as a fiduciary duty.”

The case for using index funds is compelling at this late date. The battle to bring these products front and center to 401(k) retirement plans, however, isn’t new. Two years ago, The Wall Street Journal reported on a new push to expand index fund options for 401(k) investors. But as Lieber’s story suggests, there’s been modest progress at best.
Even when 401(k) plans offer index funds, there’s less than meets the eye. Lieber notes that while 82% of all U.S. plans provide a stock index fund, a mere 37% offer a trio of domestic equity, foreign equity and bond index funds. This is a serious obstacle if you’re trying to design and manage an intelligent asset allocation strategy. As we discuss regularly on these pages, a conservative reading of the major asset classes turns up at least a dozen choices. Even if you’re one of the lucky few with the three index fund choices noted above in your 401(k), your options are severely limited relative to what’s otherwise available to the general public in ETFs and index mutual funds.
It’s clear that a basic risk-management system requires a modest degree of portfolio rebalancing. But your odds for success with rebalancing are much lower if the asset class options are constrained. Yes, you can use the wider menu of actively managed funds in 401(k) plans as a supplement, but this opens investors to all the usual caveats, including higher fees, fuzzy investment mandates, and a higher risk of earning subpar results.
It’s nothing less than astonishing that the basic investment options that provide investors with a decent chance of success over the long term are still the exception in the primary retirement account in these United States. It’s a mystery why financial regulators don’t require all 401(k) plans to offer an informed list of index fund options. Then again, maybe it’s not so mysterious. It’s Washington, after all.
This isn’t rocket science, although it is critical that investors are allowed to choose from a broad palette of low-cost betas to build portfolios. But even this fundamental building block of money management is out of reach for most 401(k) investors.